How to Control Accounts Receivable Effectively

How to Control Accounts Receivable Effectively | Accounting Smarts
Charles Hall

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Charles Hall

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March 1, 2021

Do your financial statements show a healthy bottom line, but you can’t figure out why you have no money in the bank to pay your bills?

Do your financial statements show a healthy bottom line, but you can’t figure out why you have no money in the bank to pay your bills?

If this sounds familiar, there is a good chance your money may be stuck in the invoices your customers owe.

Cash flow is critical to a company’s health, and controlling your accounts receivable helps a company improve its cash flow.

Below, we’ll cover all the different ways you can start controlling your accounts receivable more effectively to boost cash flow.

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Table of contents

Develop Accounts Receivable Policies

Effectively controlling accounts receivable starts with putting policies in place that work for your company. These policies include:

  • Developing an approval process to determine a customer's creditworthiness,
  • Deciding when to extend credit to a customer,
  • Choosing acceptable repayment terms, and
  • Reviewing a customer's account activity annually.  

Not only is it essential to decide what your policies are going to be, but you also need to ensure that your company follows them.

Develop an Approval Process

Before you extend credit to a customer, you should have an approval process in place. When deciding to offer credit, consider asking your customer for documents such as:

  • Credit application
  • Current financial statements or tax returns
  • Credit references for a credit check and lien search

These materials provide some insight into the customer requesting credit. If their credit references complain that they aren’t paid on time, this may be an indication that your customer may pay you late as well.

When looking at tax returns or financial statements, pay attention to the customer's cash balance and what they owe. If they have a lot of debt, those obligations may take priority over what you are owed.

Set Credit Limits

When you extend credit to a customer, it is a good idea to limit their purchases; this helps a company manage how much is owed to them and keeps them from extending out more than they can handle when the customer doesn't pay.

New customers often receive a lower credit limit. Once the customer has established a history with your company and a good payment record, you should consider raising their limit if you are comfortable with the customer. Raising a customer’s credit limit may motivate them to purchase more from you.

Not only is this an effective way to manage accounts receivable, but it can also translate to more sales for your company.  

Communicate Repayment Terms

Customers should know what their repayment terms are. When you extend credit to a customer, it may be helpful to have a written agreement or document that tells them what repayment terms they agreed to.

Also, be sure to include repayment expectations on any invoice that is sent to a customer. If your customer uses accounting software, they can enter the due date into their system; this helps them keep track of the date that your bill becomes delinquent.

Have an Annual Review of Customer Accounts

A company should review customer accounts regularly to make sure that they are still creditworthy. This review may include requesting and analyzing a company's current financial statements or tax returns. These documents may tell a company if their customer could have financial difficulties and may not repay what they owe.

It’s also a good idea to keep an eye on changing economic conditions that may impact your customers. Regulation or other restrictions could hinder their ability to repay your debt. On the flip side, if your customer is in a fast-growing industry, it may be better to grant them a higher credit limit to prevent them from going to your competitor.

Update Current Customer Information

Whether a company maintains its books by hand or uses software, it is essential to keep accounting records current. This ensures that the company has the correct information when sending out invoices and can speed up the payment process.

Contact Information

A company should verify that they have the correct mailing or email address for a company when sending out bills. This also includes knowing who the invoices should be sent to. It’s a good idea to verify this information when the customer places an order.

If the information is old or incorrect, your invoice may not end up where it should. It can sit on someone's desk or in their email if you send invoices electronically, which can delay payment. It may also waste more of their time trying to track down who has your invoice, as well as your time trying to get paid.

Credit Limits

It is also helpful to have a customer’s credit limit recorded within the bookkeeping software or written down in a central place. This helps to ensure that a customer does not exceed their limit when an order is placed. Should changes to a customer’s credit limit happen over time, it is essential to keep your records updated with this information.

Change the Frequency of Billing Practices

Your company will not get paid if your customers don’t have an invoice. A helpful practice to keep your accounts receivable process effective is to send bills out regularly. The best-case scenario is to do your billing every day. But what happens if your company doesn’t have someone dedicated to just invoicing customers?

In some cases, it may be the owner of the company that is sending out customer invoices. Since owners are often strapped for time, a good practice is to dedicate one day a week to billing and other administrative tasks. Each week's set time helps ensure that billing gets done while still allowing the owner to have some flexibility with the rest of their week.

It is essential to make sure that the bills that are sent out are free from errors. Double-check the quantities and prices before you send these out. If you aren't using bookkeeping software to generate invoices, be sure to double-check the math.

When invoices are sent out late, or they have billing errors, your payment may be delayed. Or, you may receive compensation in the wrong amount. Keeping your accounts receivable process as straightforward as possible helps to cut down on late payments from customers.

Make Paying Your Business Easy

Some bookkeeping software packages let you send invoices directly to your customer via email. This cuts down the time for a customer to receive your bill. Plus, they also may give the customer the option to send their payment to you electronically, right from the invoice. This can improve your chances of being paid quickly.

Your company might also consider offering multiple payment options. In addition to accepting payments by check, you could allow customers to pay by credit card or send electronic payment through their bank account. Depending on your company, you may even choose to offer mobile payment options such as PayPal, Venmo, or Apple Pay.

The easier your company makes it for a customer to pay, the better.

Encourage Buyers to Pay Early or On Time

When customers don’t pay your invoices on time, this can strain your company’s finances. After all, you still have payroll, insurance, and other bills that you must pay on time. When a customer pays late, a business owner may have to pull funds from other sources to pay the company's bills on time. This may even prevent a company from being able to make purchases to satisfy different customers' orders.

With that said, it behooves businesses to offer incentives (or consequences) to ensure customers pay their invoices early or on time.

Discounts

A helpful practice may be to offer customers a discount if they pay early. While you may pull in a little less money, having access to your funds quickly can help keep your company's finances moving. A common practice is to offer a small discount, such as 1% or 2% if a customer pays within a few days.

Finance Charges

There is a cost to your company when a customer pays their bills late. You can help offset this by putting in a finance charge if they don't pay on time. This helps cover your costs of sending invoices, statements, and making phone calls.

While finance charges may vary, they typically range between 1% and 3%.  The amount you can charge may be limited by the state your business is in, so be sure to check the rules before putting this in place.

Some states may also disallow the term “finance charges” on an invoice. You may need to use terms such as “late fees” or “service charges” to follow your state’s rules.

Post Payments Regularly

To keep your accounts receivable records up to date, be sure to post payments you receive against the open invoices as soon as possible. Like invoicing, if you can’t post payments daily, choose a set day each week.

Recording payments regularly keeps your accounts receivable aging reports current. This helps to give a business owner an accurate picture of what is owed to them at any time.

Regular posting also helps to prevent payments from being missed. It’s a good practice to deposit payments into your bank account as soon as possible to prevent them from being lost or misplaced. It also helps to ensure that the customer’s funds will be available. If too much time passes, your company runs the risk that customers will not have enough in their bank account to cover the check that they sent to you.

Verify Customer Balances

A helpful practice to put in place is to verify a customer's account's status before placing an order. If they owe you money, this can be the opportunity to get paid before placing their next order. This prevents the company from exceeding its credit limit with a customer.

If you use bookkeeping software, it can be easy to see if they still owe money. If your software allows you to put limits in place, this can also prevent a customer who has an unpaid bill to order again without someone's review.

Whether you have a manual system or use the software, keeping your accounting records current is essential to keeping a customer's open balance in check. If you fall behind in billing your customers, they may owe more money than what the bookkeeping system is reporting. Delays in posting payments may cause your sales staff to turn customers away, even though they've already paid you what they owe.

Have a Collection Process

Having a robust collection process helps to keep your accounts receivable function useful. While collecting past-due payments from customers may be uncomfortable, it's necessary to help keep a small business financially viable.

Customer Statements

It’s a good practice to send out customer statements every month. These serve as a friendly reminder that they owe your company money.

Statements also serve another purpose. A customer may contact you to let you know that they've already paid a bill that you are showing as unpaid. This allows the company to check their records to ensure that they've posted payments received and to the proper accounts. In other cases, it may be an indication that your company never received the check or that it hasn't yet been deposited.

Reminders

Consider sending reminders to your customers. These can be friendly letters or postcards that remind your customers that they have an unpaid balance with you.

A company may have multiple letters that it sends out to remind customers that they have a balance due. Different letters may be sent based on how late a customer is with their balance. A customer who is nearing the 30-day mark may receive a friendlier letter than one who is over 90 days late.

Accounts Receivable Aging Reports

An accounts receivable aging report shows which customers owe money and how old their invoices are. If you use bookkeeping software, this report is easy to generate.

This report should be reviewed in connection with the policies you’ve set for credit limits and the time given to pay. If you have extended credit to customers, this report helps you determine if they are meeting your expectations.

For collection purposes, use this report to focus on accounts receivable that have exceeded your payment terms. If your terms require customers to pay within 30 days, it’s also helpful to send them a quick reminder that their payment is coming due.

Stay in Touch

Make it a point to keep in contact with customers that have open balances. They may be experiencing delays in sending your payment. A customer may be in a similar situation as you are where they are waiting for an open invoice to be paid on their end so that they have the funds to pay you. Or there could be changing economic conditions or other issues preventing them from paying.

By keeping the lines of communication open, it can help in getting your invoices paid. If they are experiencing a delay on their end, you are now aware of it and may be able to plan your finances differently to accommodate this until the check comes in.

Payment Arrangements

If a customer is experiencing a problem with making their payment, consider offering them a payment arrangement. While this will delay the funds coming to you, it may help to ease your company’s financial burden to receive something now.

If this is a long-standing customer, this can improve your relationship with them if they know you are willing to work with them during a difficult time.

Collection Agency

When all else fails, a collection agency may be your only alternative. They typically charge for their services, which may be based on the percentage they collect or a set amount that you’ve agreed to.

Collection agencies take the burden off the business to collect old accounts. They typically send a series of letters and make phone calls to collect the balance due. In some cases, they may even bring legal action against the customer.

A collection agency should be the last resort. A company should make all attempts possible to collect what is due or work out an arrangement before sending it to an agency. If this is a customer that you'd like to continue doing business with, sending their account to a collection agency may damage your relationship.

Use Bookkeeping Software

If you maintain your accounting records by hand, consider upgrading to a small business software package. There are many bookkeeping software packages available today, such as QuickBooks and Xero. These programs are made for small business owners and are easy to set up and use.

A software program makes it easier to track your company’s activity with the touch of a key. Once you've set up your customers in the system, they can be invoiced based on the data you've entered. Any contact information and credit terms that you've set up in the system come up automatically. And as payments come in, they can be posted against the open bills.

Invoicing

A small business bookkeeping program allows you to invoice your customers easily. Invoicing through a software program is helpful for an owner in many ways:

  • It eliminates clerical errors that can happen when you prepare an invoice by hand
  • It keeps a record of what has been billed
  • Easy to track which invoices have not been paid
  • It helps to keep customers from exceeding their credit limit

Not only does invoicing through bookkeeping software make your accounts receivable process more effective, but an owner can also run reports that give them a better picture as to how their company is doing. Sales are automatically entered into the software, which saves time.

Review Accounts Receivable Reports

Invoicing through bookkeeping software gives the ability to stay on top of their accounts receivable balances. These programs can generate helpful accounts receivable reports, which an owner can use as a tool to monitor their customers’ accounts. It is easy to see who owes you money and how much.

You can also run reports by the age of the open balances. This helps you identify potential payment problems associated with older invoices and prevent customers who owe money from buying more until they’ve paid down their balances.

It may also give an owner insight into how their customer accounts perform. As mentioned above, for a customer who regularly pays their bills on time, an increase in their credit limit may garner more sales. Conversely, a customer who continually pays late may need an alternative structure, such as a lower limit or a requirement to put down a deposit on each sale.

Use an Outside Bookkeeping Company

As a small business, you may not have the resources to handle your bookkeeping needs. You may not have the time to dedicate to billing customers and following up on open balances.

Outsourcing your bookkeeping functions can help you with these tasks. Depending on the services you need, an outside bookkeeping or accounting firm can help you stay on top of your company's billing, payment, and collection processes. This can keep your records current and ensure that your customers are receiving their bills timely.

This also separates you from collecting on open balances. A customer may be more responsive if a third party is contacting them about the money they owe.

Factor Accounts Receivable

For companies that face cash flow issues, factoring their accounts receivable may be a viable option.

When you factor accounts receivable, you are essentially selling open invoices to a financial institution at a discounted price. After deducting their fee, the institution sends the company a check for the remaining amount. Even though less money is being received, a company can convert their accounts receivable to cash quickly.

When factoring invoices, the financial institution will evaluate their collectability.

Factoring with Recourse

When a company factors their invoices with recourse, they guarantee the financial institution that the customer will pay. If the customer doesn’t pay, you will be responsible for paying the financial institution back for any funds that they advanced to you.

The fees for factoring with recourse may be less because you guarantee that the buyer will get their money back.

If your customers are good about paying their bills, this may be the most cost-effective means for your company.

Factoring without Recourse

When a seller purchases your accounts receivable without recourse, this means they bear the financial burden if the customer doesn’t pay. The seller will typically charge higher fees under this scenario since they aren’t guaranteed to get their money back.

Factoring without recourse can be the more expensive option of the two. But if your customers are relatively new or don’t have a great payment history, this may be the better option to take. The business will receive a lesser amount, but they at least receive something.

Conclusion

Placing effective controls over your accounts receivable system is critical to keeping your company operating as it should. After all, when customers pay their bills on time, you can pay your employees and vendors on time.

But if your company is crunched for cash and is struggling to pay bills, your accounts receivable may be the problem. Whether it is a customer that just pays late or one that doesn’t pay at all, or your cash flow is disrupted, it can have a significant impact on your company’s ability to operate and grow. You may be forced to pay your vendors late, which can damage your relationship with them. You may incur late fees and penalties when you fall behind as well.

To keep your company operating as it should, controlling your accounts receivable is crucial. Establishing sound policies and performing a thorough review of a company's ability to pay can go a long way to getting paid. A robust collection procedure can help you recover the money due to your company without damaging your relationship with those customers who may fall behind in paying you. Not only does an effective accounts receivable process help to keep your company operating as it should, but it can also impact its ability to grow and thrive in the future.

Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall